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09 December 2013

Income-Inequality Revisionism

Obama rewrites the history of the Reagan revolution as the beginning of the bad times.

By James Pethokoukis

To consider only the seen while neglecting the unseen, as 19th-century political economist Frederic Bastiat warned, risks cognitive errors. Policymakers must try to imagine the counterfactual when making a decision, taking an action, or analyzing history.

President Obama’s big speech on inequality last week illustrates vividly the value of asking, “What if . . . ?” Rising income inequality and declining economic mobility, the president declared, are “a fundamental threat to the American dream, our way of life, and what we stand for around the globe.” This factually suspect argument is put forth by Obama to promote his agenda of higher taxes, a higher minimum wage, and higher spending. To support it, he gave a revisionist history lesson worthy of Howard Zinn.

Many Americans recall the 1980s as the beginning of an improbable Long Boom when pro-market polices reversed what at the time had seemed like unstoppable economic decline. Obama, however, described the Reagan revolution as the moment when the postwar “social contract began to unravel” and “trickle-down ideology became more permanent,” leading to decades of dangerously unbalanced economic growth. The rich got even richer as middle-class incomes stagnated. The Age of Inequality had begun.

Actually, middle-class incomes rose roughly 40 percent from 1979 through 2007, and nearly 50 million net new jobs were created. (As President Reagan said on leaving office, “All in all, not bad, not bad at all.”) But leave aside Obama’s factual errors. What’s the president’s counterfactual? What would America be like today had it not embraced center-right reforms such as deregulation, tax cuts, and free trade? What if government had prevented the mergers and takeovers that enabled Corporate America’s necessary restructuring?

An educated guess is possible thanks to two large advanced economies that provide a pair of natural economic experiments. Unlike Reagan’s America and Thatcher’s Britain, Japan in the 1980s declined to undertake “neoliberal” reforms to open its economy, as finance professor Noah Smith recently noted in Foreign Affairs. Corporate taxation there today is high, key industries such as retailing and agriculture are protected from competition and subsidized, and labor markets remain tightly regulated. Workers don’t move around much. Sure, Japan has less income inequality. But it also has less dynamism. Over the past two decades, Japan’s per capita GDP has fallen from 85 percent of America’s to 71 percent. Indeed, one of Prime Minister Shinzo Abe’s “three arrows” of economic reform is injecting more competition and churn — creative destruction, really — into the Japanese economy.

Then there’s France, which continues to sniff at the “Anglo-Saxon” style of capitalism. Taxes there are high and headed higher, unions are strong, and inequality is low. Its per capita GDP is also only a bit more than two-thirds of America’s, and France is hardly anyone’s idea of a dynamic economy pushing the technological frontier. Oh, and the French economy seems on the verge of its third recession in five years.

Now both France and Japan are wealthy nations with some big, successful multinational corporations. And each has a vibrant culture. But would anyone say they are flourishing? From these examples, we can reasonably conclude that if America had rejected the Reagan revolution, we might well have less inequality today, but we would probably also have less wealth, entrepreneurship, innovation, and, when you think of it, less fun. Further evidence for our counterfactual: a 2009 study by researchers Dan Andrews, Christopher Jencks, and Andrew Leigh that found that more inequality is actually associated with higher GDP growth. Obama mentioned lots of stats and studies in his income-inequality speech, but he somehow failed to cite this one.

Of course, it may not feel like America is prospering right now, either. While the economy added a better-than-expected 203,000 jobs last month, there are still nearly 4 million fewer full-time workers today than before the Great Recession. But it could be worse. At least America is growing and adding jobs. If we’re going to do a lot better, though, we need to draw the right lessons from the past — not distort it to promote stale ideological agendas.

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